Enhanced CAC’s and the Coming Sovereign Debt Courts
By JC Collins
Every once in a while I like to dig a little deeper into the complexity of the monetary architecture and the growing sovereign debt challenges which many nations face. These challenges are huge and will take a true multilateral approach to traverse the rugged terrain and reach sustainable solutions. The average posts here only deal in the broad strokes and are unable to transfer the full depth of the multilateral methodology.
The complexity itself can only be processed in stages and intervals. There are likely only a handful of economists and socioeconomic strategist in the world who can fully grasp the intricate mechanisms and related macroprudential policies which are required to address these challenges. There are also other weirdos out there (in addition to myself) who get their kicks from researching and pondering such things.
Perhaps you, the person reading this right now, is such a weirdo. Perhaps not. Perhaps you have stumbled into the POM (Philosophy of Metrics) maze of mysteries for the very first time and feel overwhelmed with the amount of information available here. Fear not, there are many readers and commentators here, in the POM family, who will help you along and assist in answering questions and directing a healthy flow of common debate.
Such is the environment of understanding which we have developed here over the last two years. This site is free of the emotion based doom and gloom analysis which roll from month to month with new and clever promotions of collapse and the end of western civilization.
As entertaining as these articles are to read, they do very little to actually increase awareness and understanding of what the real monetary challenges are, and what shape the probable solutions will take. Let alone address the inherent human deficiencies which are passed from monetary system to monetary system, like DNA is passed from mother to child.
The mysteries of form and function.
Regardless of these deficiencies, our collective efforts to bring a sense of understanding to the monumental monetary changes which are taking place has been so far successful. Each month more and more readers are coming to the POM site and beginning the awakening of intelligence. This awakening is required to break free from the endless propagations of doom, and begin the process of climbing out from under the confusion which lays over the disorganized masses like a wet blanket.
Will there be economic instability? Yes. Will there be a transfer of wealth? Yes. Will there be revolutions and wars? Yes.
All of these things have been with humanity for thousands of years, and will continue to be with us for a thousand more. But losing ourselves in the fear and hopelessness of what has been and what may yet be, is self-defeating and demoralizing. Which is why I have focused on the details and facts surrounding the monetary framework.
One of the biggest issues facing the monetary and financial world in our time is the threat of sovereign debt defaults. The easy spending of days past has created a situation which is unsustainable and sustainable solutions must be developed and implemented in order to transition to a more multilateral and equitable monetary framework.
POM reader and commentator Jenifer Lytle stated it with perfection today while commenting on the post TPP and AEC – Parallel Trade Agreements. In reference to the USD hegemony which has developed under the existing unipolar system, she wrote:
“Yes I am optimistic that alleviating a militarized USD hegemony from the global economic stage could be a good thing for all concerned. This is the road to achieving that, and no doubt it is filled with controversial pros and cons, as usual. People will always have contrasting views based on personal experiences and beliefs of right v. wrong, good v. bad, and seek expression of such views. I respect your need to defend the insanity of duality. Even if I did or didn't like what's in the agreement I cannot change it, I can only hold the highest thought for a significant step towards fundamental change.”
Jenifer stated in only 107 words my complete perspective on the multilateral monetary transition. It fits within my own personal mandate of planning for the worst and hoping for the best. With all planning information is key. That is the importance of this site and why I write as profusely as I do. Understanding the facts and probable solutions are the first step in devising our own personal plans on how to traverse the terrain and protect ourselves. Sovereign nations themselves are also attempting to understand the full scope of this transition, with many still falling behind on monetary policy and financial regulations.
Over the last year I have been approached by large corporations and a few members of regional governments, all with various questions on this transition. The complexity and depth of the structural reforms which are required to balance the international monetary and financial systems are even difficult to understand by those who have been mandated to understand it.
Politicians who have been voted into office on the faith of the electorate which they represent are unable to understand, let alone communicate to that electorate, the form and function of monetary transformation. This failure has little to do with each politician or board member, and more to do with our collective unwillingness to demand intelligence and accountability from those who represent and guide us.
We are given only what we demand. That is human nature. There is only a small percentage of the population which cares about these matters, which is why politicians and corporate representatives either have a low understanding of it, or chose not to discuss it en masse.
It should be mandated that those in positions of power and influence promote a broader understanding of such things, and in turn expect more from the electorate than non-consequential talking points and fraudulent all-encompassing election issues. These are concepts which I will discuss in more detail in an upcoming piece on politics and responsibilities.
Sovereign debt challenges are faced with varying and differing responses from the nations and institutions of the world. Without a unified multilateral framework on sovereign debt restructuring hammered out by nations and global institutions, each region and country are forced to deal with these challenges alone, or in smaller regional groupings than what the challenge itself would ultimately require.
As such, the responses to this growing problem have consolidated into two opposing camps. These differing solutions are represented by the sovereign debt restructuring strategies called SDRM and CAC.
Back on May 27, 2015, I published a piece titled The Sovereign Debt Complex – How China and America Are Waging a Quiet War over Sovereign Debt Restructuring. In that post I explained in more detail the roles of the SDRM and CAC, as well as the support each receives from China and the US.
“There are two much discussed methods of sovereign debt restructuring. One is called Collective Action Clauses (CAC), which is a more market oriented solution desired by private investors and some sovereigns, such as the United States and Japan. The US would seek a market oriented solution such as CAC’s because of the market dominance of the dollar. Emerging markets, like China, are concerned about the negative market effects of a CAC, based on increased costs and further currency debasement.”
“The other is the Sovereign Debt Restructuring Mechanism (SDRM), of the International Monetary Fund. The SDRM, or a modified version of the SDRM, is a structural (non-market) solution to sovereign debt, which is desired by China, and other emerging economies. The obvious nature of the non-market structural changes involved with the SDRM process does not give the largest debtor nation, America, the ability to leverage the process against the needs of the developing countries which largely hold US debt, such as China.”
Given the American reluctance to pass the 2010 IMF Quota and Governance Reforms, and participate in overall international monetary system reforms, we can expect that any sovereign debt restructuring will also fall under the US mandate of a unipolar hegemonic approach.
The SDRM would be a process which is facilitated through the International Monetary Fund itself. While the CAC would be outside of the IMF working groups and governance board. Considering the intent of the IMF and World Bank, as well as the emerging markets, largely represented by China, to bypass the United States on monetary reform and implement change for the international common good, we can expect that America would attempt to leverage their dominate position towards the more beneficial CAC approach.
It is with that in mind that we reference a recent IMF briefing made at the G20 meeting held on September 4, 2015. This briefing, titled IMF-Note-on-Inclusion-of-Enhanced-Contractual-Provisions-in-International-Sovereign-Bond-Contracts-Briefing-for-G20-Meeting, lays out a framework in which an enhanced CAC can be used.
From the briefing:
“As part of the IMF’s ongoing work on sovereign debt restructuring, the Executive Board endorsed in October 2014 the inclusion of key features of enhanced pari passu provisions and collective action clauses (CACs) in new international sovereign bonds. Specifically, the Executive Board endorsed the use of (i) a modified pari passu clause that explicitly excludes the obligation to effect ratable payments and (ii) an enhanced CAC with a menu of voting procedures, including a “single-limb” voting procedure that enables bonds to be restructured on the basis of a single vote across all affected instruments, a two-limb aggregated voting procedure and a series-by-series voting procedure. Directors supported an active role for the IMF in promoting the inclusion of these clauses. The IMF’s endorsement was followed by calls from the IMFC and the G20 to promote the use of the enhanced clauses and report on their inclusion.”
It is clear that the IMF is willing to entertain and accept the US lead initiative to use CAC’s as the form of sovereign debt restructuring. At least for a percentage of bonds held by strategic American partners. It is also just as likely we could see some sovereign debt restructuring completed through the SDRM for other markets, such as the emerging countries. Interestingly enough, it is the developed nations, mostly American partners, who have the highest levels of sovereign debt, and not the emerging ones, like China.
But it is China, and other emerging market countries, which hold the highest amount of American debt. This is where the SDRM could come into play as opposed to the CAC.
The Center for International Governance Innovation recently published a working document titled Simplifying Sovereign Bankruptcy: A Voluntary Single Host Country Approach to SDRM Design. This document further defines the opposing strategies of SDRM and CAC’s.
The thesis presented is that a court based sovereign debt restructuring mechanism can be developed. It is assumed, likely under US leverage that a global mechanism (SDRM as defined) on sovereign debt restructuring will not work.
The document lays out the possibility that a single country could set up a sovereign debt court and invite debtor nations to use its legal system to gain the benefit of the mechanism. It is argued that this process would simplify the set up and operation of an SDRM or CAC. It would also lower the possibility of holdout investors (bond holders) causing disruptive litigation against the process.
It is also defined that while negotiations are taking place, the court system could allow for deferred principle payments as long as interest payments are made. This sounds all constructive and non-judicial, but the process itself is still geared towards a US hegemonic and unipolar approach, even though the term SDRM us being used.
There are reasons why I state this. First, the host jurisdiction is defined as being at the state level. There are two large bond markets which issue the majority of the world’s bonds. They are found under English Law and New York Law.
New York Law specifically, has the vast majority of sovereign international bonds issued under its regulation. As such, the New York Law court system is well respected and trusted around the world when it comes to sovereign debt and bond issuance. The possibility also exists that New York Law could also facilitate both sovereign debt restructuring mechanisms.
In the G20 briefing paper by the IMF, the following information is given:
“Since the Executive Board’s endorsement, substantial progress has been made in incorporating the enhanced CACs in new international sovereign bond issuances. Based on information available as of July 31, 2015, there have been 72 international sovereign bond issuances since October 1, 2014, for a total nominal principal amount of approximately US$85 billion. Of these, 41 issuances, representing 59 percent of the nominal principal amount of total issuances, have included the enhanced CACs. The 21 issuers that have included the enhanced CACs are:
- Under New York Law: Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Indonesia, Jamaica, Mexico, Panama, Turkey, and Vietnam; and
- Under English Law: Armenia, Bulgaria, Croatia, Egypt, Ethiopia, Gabon, Kazakhstan, Montenegro, Tunisia, and Zambia.”
“For purposes of understanding why certain bond issuances have not included the enhanced CACs, it is helpful to divide the international sovereign bonds issued since October 1, 2014 into two categories. The first category comprises new issuances (either issued on a stand-alone basis or under a new “shelf” registration statement or a new medium term note program established or updated on or after October 1, 2014), which account for approximately 70 percent of all issuances (as a share of total nominal principal amount). About 85 percent of these issuances included the enhanced CACs (as a share of nominal principal amount). The second category includes “re-openings” of previous issuances or “take-downs” under programs established prior to October 1, 2014, and not updated since that time, which accounts for the remaining 30 percent of all issuances (as a share of nominal principal amount). None of the bonds conducted as “re-openings” or “take-downs” under existing programs included the enhanced CACs. This is consistent with current market practice, whereby issuers typically do not amend bond terms when conducting “re-openings” or “take-downs” (inter alia, to preserve the speed of issuance and fungibility of the new bonds with an issuer’s existing bond series).”
“The uptake of enhanced CACs was greater for new issuances under New York law than English law. Of the new issuances, approximately 91 percent of the New York law governed bonds included the enhanced CACs, while approximately 75 percent of the English law governed bonds included the enhanced CACs (as a share of total nominal principal amount). Of the 91 per cent, approximately 75 per cent were issued by Latin American issuers. It is too early to identify definitive reasons for non-incorporation of the enhanced CACs in some new issuances and the uptake differential between the New York and English jurisdictions.”
From these documents and briefings it is beginning to look like a very real possibility that both the SDRM and CAC process will be used when it comes to sovereign debt restructuring. Most will agree that sovereign debt is a huge issue which will need to be addressed sooner rather than later.
The governments of the world are ill prepared to address this issue head on and will likely leave the actual implementation of any mechanism up to the international institutions and court systems. Outside of New York Law and English Law, other jurisdictions which could facilitate court based sovereign debt restructuring could be in the Netherlands, Canada, Switzerland, France, Germany, and Sweden. Given the lack of trust in Chinese courts, it is unlikely that this method of restructuring would take place through any court systems in China. Which is why the SDRM method utilized through the IMF itself would facilitate that component for the emerging markets.
Though the language is humdrum and somewhat confusing, I would encourage all readers to make themselves familiar with the information that is presented in both the briefing and document linked in this post. The time spent understanding these often misunderstood mechanisms will mean the difference between continued confusion and susceptibility of erroneousness doom and gloom predictions.
The approaching sovereign debt crisis will rapidly spread and the framework to manage this crisis is already being built in court systems around the world, with a strong focus on New York Law and to a lesser extent, English Law. This is the real world of high finance and sovereign law. It would do us well to understand it as best we can. This restructuring will be necessary for a full transition to a multilateral monetary framework. - JC
 The sample includes international sovereign bonds issued between October 1, 2014 and July 31, 2015, except: euro area sovereign issuances (as they are required under EU law to include euro area-specific CACs), China’s domestic issuances under Hong Kong law, and GDP warrants. There may also be international sovereign bond issuances (e.g., private placements) that have not been captured by the database relied upon by staff.
 The UK has also included enhanced CACs in its recent English law-governed US dollar-denominated bonds issued by the Bank of England. International sovereign bonds issued by Euro area countries during the period October 1, 2014 to July 31, 2015 did not include enhanced CACs (the issuers were: Lithuania, Cyprus, Finland, Luxembourg and Spain); as noted above, these issuers are required to include euro area specific CACs.
 The issuers in this category that did not include the enhanced CACs are: under English law, Cote d’Ivoire, Pakistan and Poland; and under New York law, Mongolia, the Philippines and Sri Lanka. Also, recently issued sukuk, such as those issued by Malaysia, Hong Kong and Turkey (all under English law), have not included the enhanced CACs (the Hong Kong and Turkey issuances included series-by-series CACs, whilst Malaysia also included a two-limb aggregated CAC in line with the ICMA model clauses).
 These issuers are: Under New York law, Colombia, Lebanon, Paraguay, Peru, Turkey, Uruguay; and under English law, Poland, Romania, Kenya and Sweden. Namibia’s June 2015 issuance under South African law and Indonesia’s May 2015 sukuk issuance under English law also did not include the enhanced CACs.